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Takeaway: CACC, STAY, GIL, CMG, MD, ZBH, TPR, SBUX, CCL, UNFI, ALRM, SGRY, TSLA, SHAK

Investing Ideas Newsletter - 09.26.2018 Fed hike cartoon

Below are analyst updates on our fourteen current high-conviction long and short ideas. We will send a separate email with Hedgeye CEO Keith McCullough's refreshed levels for each ticker.

IDEAS UPDATES

CACC

Click here to read our analyst's original report.

Credit Acceptance Corp (CACC) Management: Great Operators + Seasoned Veterans: Publicly traded since 1992, the only unprofitable year in the firm’s 25-year history of being public was 1999. Even more remarkably, GAAP EPS grew +23% and +113% Y/Y in 2008 and 2009, respectively. Also notable is the fact that in the last 25 years, CACC has only had EPS decline in 4 years.

CACC’s 28-member management team, averaging 15 years of experience/person, has proven to be good stewards of capital. CACC has spent roughly $1.5 billion over the last 13 years buying back shares, roughly cutting the diluted share count in half.

In addition, incentive compensation is determined by economic profit: earnings produced in excess of the imputed cost of capital. At Encore Capital Group, a business not dissimilar from that of Credit Acceptance Corp., the management team earn a short-term, cash incentive based upon adjusted EBITDA targets –a firm-level performance metric. That is, management at Encore is rewarded in the short-term for taking on leverage. In refreshing contrast, executive officers at CACC have their compensation tied to the ROIC that they generate. This should not be looked over.

In sum, CACC’s management is a tried, tested, and proven asset to the firm.

STAY

Click here to read our analyst's original report.

Extended Stay America (STAY) has significant operating leverage (owns majority of hotels), making its near-term earnings positively leveraged to the accelerating RevPAR environment. Moreover, refranchising will contribute to significant free cash flow generation and more of an asset light growth model - a key driver of long term multiple expansion.

GIL

Click here to read our analyst's original report.

Gildan Activewear (GIL) is launching a new polo shirt brand called Prim + Preaux in January. The new styles will dramatically increase Gildan’s competitive offering in polo shirts and highlights an expanded product assortment capability it did not previously have. The new offering also highlights a more focused effort to penetrate the corporate market. (Think Best Buy, Staples, etc store associates wearing polos.) It will consist of 25 styles ranging from traditional polos to long-sleeve quarter zips (which GIL believes has largely replaced long-sleeved polos). There are also several styles designed specifically for women.  The plan is for the new brand to expand into other corporate wear in the future. The corporate/workwear market is large, greater than $15B, although this would represent just a portion of it. It does share in common many of the same middlemen as the screen print market. I think that the Street is grossly underestimating the top line growth ramp we’ll see at GIL over the next 12-18 months. It’s one of my Best Long Ideas today.

CMG

Click here to read our analyst's original report.

We are looking past near-term ebbs and flows, and to the long-term prospects for Chipotle Mexican Grill (CMG). We believe CMG has a great opportunity to get to a $3M AUV longer-term (enabled by their second make-lines), and reviving the margin profile of the business back to historical averages. By 2021, we could be looking at a company with ~5% unit growth, ~5% comp, ~$6.6B revenue, ~23.5% RLM, ~$25.75 EPS, and a ~$12 dividend per share, we think people will put a premium multiple on that!

Investing Ideas Newsletter - cmg1

MD

Click here to read our analyst's original report.

Here are key thesis points on our Mednax (MD) long call:

1. Maternity Stable to Improving:

  • Birth trends appear likely to stabilize and inflect higher throughout 2018 due to Zika compare
  • Demographics of marriage and maternity deferral turning positive as 30-39 age cohort accelerates
  • A recovery in maternity is a positive tailwind for 50% of MD revenue and margins

2. Activist Pressure/Take-Out:

  • Activist investor Elliott Management has taken a 7% stake near $43/share which is driving take-out speculation
  • The activist is addressing productivity in anesthesiology helping to recover 100s of basis points of lost margin
  • Company has hired BofA to explore private equity interest

3. Physician Consolidation and Atrium Lawsuit:

  • Consolidation among physician groups is accelerating, likely allowing MD to reaccelerate acquisition growth
  • Irrational competition for deals appears to be abating; EVHC is under stress and appears to not be competing for deals as aggressively
  • Atrium, while a negative outcome for MD revenue, validates the model and is margin positive

ZBH

Click here to read our analyst's original report.

 We spoke with an Orthopedic Surgeon at an Academic Medical Center in New Jersey about volume trends, contracts with manufacturers, robotics and large joint shift to an ASC. Our contact is a Zimmer Biomet (ZBH) loyalist, having trained on Zimmer through his residency and fellowship, and currently performs 200 total knee replacements a year.  While our contact experienced limited supply issues with Zimmer, he was aware of other surgeons outside his health system that had supply problems with Zimmer's cementless knee.  Our contact believes his hospital was likely an exception to Zimmer's supply problems as they were a top account.  Our contact feels strongly that robotics is the future despite the limited clinical evidence, and that implant agnostic platforms will be preferred over razor/razorblade systems, such as Mako. 

While the hospital has a Mako robot, and most surgeons are trained on the system (including our contact), 80-90% of surgeons at his hospital still choose to use Zimmer implants.  The biggest takeaway from our conversation was that the hospital is in the early stages of transitioning to system-wide contracts for implants, and is considering offering a generic option.  The hospital is currently paying $4,000 - $5,000 for Zimmer's Persona knee, versus the generic price of $2,000.  Our contact sees Zimmer losing some market share to generic implants as "inevitable," although we are still years away from seeing significant adoption.

TPR

Click here to read our analyst's original report.

This week Michael Kors announced an agreement to purchase Versace for $2.1B. One of the reasons Tapestry (TPR) changed its name from Coach was to highlight that the company would be comprised of a family of brands. Tapestry was one of the companies that reportedly looked at purchasing Versace. We think acquisitions is part of Tapestry’s long term strategy and the fact that it’s taking a look at Versace confirms it has an appetite.  Though, with the price that KORS offered, we’re glad TPR is being more measured with its M&A moves to avoid deals of a dilutive nature.

Tapestry has added companies that provide a benefit from its size, scale, market expertise, and product expertise. That’s what Stuart Weitzman and Kate Spade added.  TPR has a limited presence in Europe and it would not surprise us if the next acquisition was a company with a large presence there that could provide revenue opportunity synergies for the other brands.  

SBUX

Click here to read our analyst's original report. 

This week news broke that Starbucks (SBUX) CEO apparently wrote a memo with the subject line "Building our future together," and goes on for six paragraphs before delivering the jobs news that "starting next week and into mid-November there will be leadership shifts and non-retail partner impacts as we evolve the direction of teams across the organization in size, scope and goals."  This is not good news to the people losing their jobs, and not good news for FY19 earnings guidance or the growth algorithm. 

The current street estimates are 5% revenue growth, 5% operating profit growth, and 11% EPS growth!  Clearly, before “the memo” the company was going to struggle to make those numbers and now after “the memo” it is a clear indication that there is significantly more trouble to come!

CCL

Click here to read our analyst's original report.

Carnival (CCL) disappointed investors this week.  The company guided 1H 2019 yield growth to “below Q4 2018’s” aka below the 2% midpoint.  That is substantially below growing expectations and even below our estimate, as we have been modeling another year of yield deceleration for CCL.  As we highlighted in our note CCL VS RCL | TRADING PLACES, CCL looked like the weakling heading into 2019, particularly on Caribbean pricing.  As for 2018, CCL did raise FY yield growth guidance to 3.5%, as we expected, but cost guidance was hiked as well, “primarily due to the accounting treatment for ships sold in Q3”.  3.5% yield growth in 2018 trails actual 4.5% growth in 2017.  

Q3 yield growth was only in-line despite the big runup in the stock price since August.  The lack of hurricanes disrupting the Caribbean this summer had boosted sentiment and bookings but looks like it’s not enough to change CCL’s forward pricing language of “in-line.”  In fact, without the Labor Day boost, prices since June were running lower YoY.  Higher European prices are offsetting lower Caribbean pricing but this is not translating into higher yield growth.  Our deceleration yield theme remains intact.

UNFI

Click here to read our analyst's original report.

United Natural Foods (UNFI) is facing long-term structural headwinds to gross margin, headlined by the customer mix shift to lower margin customers, Whole Foods and Conventional. 

This business is truly falling apart across the financial statements. UNFI is turning into a long term structural short in which margin upside will prove very difficult given the customer mix shift and pricing pressure headwinds.

ALRM

Click here to read our analyst's original report.

Alarm.com (ALRM) sits in the eye of market disruption as its leading position in interactive home security systems faces a torrent of new digital systems with innovative business models, customer acquisition, and technology. Meanwhile, the market opportunity for ALRM has exploded in the last few years, but ALRM has not. The stock is expensive on FCF…and OCF/EBITDA improvements in 2017 were mainly inorganic and not repeatable.

SGRY

Click here to read our analyst's original report.

Surgery Partners (SGRY) management's 2018 guidance of at least $240M was before the impact of acquisitions, and we are modeling $234M including acquisitions and assuming COGS only increase 2% 2H18/1H18. Management's reluctance to quantify the cost savings from the new GPO contract during the earnings call, and commentary that their EBITDA guidance is "heavily weighted towards the fourth quarter," reinforces our view that 2H18 EBITDA estimates are at-risk. 

TSLA

Click here to read our analyst's original stock report.

Fraud Is Toxic For The Tesla (TSLA) Brand & $4.20 Secured?

Our test drive utilization metrics have continued to absolutely collapse, along with other brand indicators.  Buyers may reasonably not want a car from a CEO accused of fraud and misleading investors.  The drop is so sharp that it may partly relate to shifting delivery priorities (we understand the Greenwich dealer shifted some personnel to Mt Kisco to help for example).  Still, we don’t see how an institutional long can persist on a brand-based thesis with data series like this accumulating.  Most likely, Musk will settle at some point, but damage has already occurred, and prior to the tax credit step down, etc., the timing of the bad press couldn’t be much worse.

Investing Ideas Newsletter - tsla

SHAK

Click here to read our analyst's original Shake Shack report.

Black Box and Knapp-Track same restaurant sales (SRS) and traffic (SRT) took a turn for the worse against some of the easiest comparisons in recent history.

Black Box SRS for July was 0.54%, representing a 120bps sequential decline in the 2-year average to -1.1%. SRT for July was -1.8%, representing a 90bps sequential decline in the 2-year average to -3.2%. 

Knapp-Track SRS for July was 0.60%, representing a 190bps sequential decline in the 2-year average to -1.3%. SRT for July was -2.0%, representing a 170bps sequential decline in the 2-year average to -3.7%.

The continued negative traffic trends speak to broader problems the restaurant industry faces with being overstored, which is not a new trend. Hence our dislike for restaurant companies with negative traffic and high unit growth rates (Shake Shack - SHAK), it’s not a sustainable allocation of capital!

As we head into the back-half of 2018 and 2019 when we start to lap improved performance and the one-time tax reform bump, we believe that the large casual dining chains will struggle to perform. Furthermore, thinking longer-term as delivery grows as a percent of total sales for brands, it will be extremely margin dilutive (and likely not as incremental as everyone thinks) which will put some restaurant company management teams in a precarious situation.